Different Investment Criteria and How to Calculate Them

Investment trends continue to skyrocket since many people are financially literate. However, not everyone learns what investment criteria are so that they can bring in a lot of profit.

Investment itself is an activity of investing, either directly or indirectly, with the hope that there will be profits derived from the investment.

Those of you who intend to invest need to know what investment criteria are so that you can find the best investment instrument that suits your needs and risk profile. To determine these criteria, there are special ways that can be done. What are the criteria and calculations in question? Check out the following explanation.

What are Investment Criteria?

Investment criteria are assessments carried out to measure profits or returns that will be obtained by investors and the amount of costs incurred for an investment instrument.

In the process of investing, you need to incur additional costs or often called investment costs. These costs include transaction costs when purchasing an investment instrument.

Almost everyone knows that investing is an activity that is not only profitable, but also risky. This risk is an important part to consider so you need a strategy to avoid it. By determining the best investment criteria, you can avoid these risks from the start.

Various Investment Criteria 

As previously explained, investment is an activity related to the investment and withdrawal of funds in the form of certain instruments. To find out the right instrument for investing, you need to study the following types of investment criteria.

1. Payback period

Payback period  is an investment criterion that can be defined as the time to return an investment or the time for an investment to break even. This criterion is often also called the principal return period. The shorter the time required, the better the investment proposal. This criterion can be calculated using the following formula.

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Payback Period  = The amount of the investment value of net cash inflow x 1 year 

By using this formula, it can be seen that the faster the ability of a project to recover the costs that have been spent in investing, the better the project in terms of time.

2. Gross benefit cost ratio 

The B/C  ratio  or  gross benefit cost ratio  is an investment criterion that refers to whichever is much greater between the costs incurred or the results obtained. 

The costs incurred will be calculated as  costs  (C), while the results obtained will be calculated as  benefits  (B). The formula for calculating the B/C  ratio  will involve  the present value  , which is abbreviated as PV. 

B/C ratio = PV benefit/PV cost

If the value of B/C is less than 1, then the value of B is smaller than C. That is, the profit gained from the investment is smaller than the costs incurred. On the other hand, if the value of B/C is greater than 1, then the value of B is greater than C. This means that the investment is feasible to continue.

3. Net Present Value (NPV) 

The next investment criterion is NPV. Unlike the previous two criteria, NPV cannot be calculated using nominal values ​​because this criterion takes into account the value of money based on time.

The calculation of investment feasibility based on the NPV criteria is used to determine the current asset value which is equated with the projected asset value in the future. This needs to be done because the value of money in the present will change so you need to know whether the value is still profitable or even detrimental.

The formula that can be used to find the NPV is:

NPV = FV / (1+i)^n

Information:

FV = Future value

i = discount factor

n = investment period

If the value is more than zero, it means that the NPV is positive so that the investment project is feasible to choose. Conversely, if the value is less than zero, it means that the NPV is negative so that the investment project is not feasible to choose.

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4. Internal Rate of Return (IRR)

This investment criterion is usually called the IRR, which is the feasibility of an investment seen from the internal rate of return or the ability of a project to generate  returns

IRR calculations are generally used to determine the annual profit of an investment project and the company’s or project’s ability to repay loan interest.

By calculating the IRR criteria, you can find out what percentage of profits are obtained from a project and measure the ability of a project to repay loan interest. 

Here’s how to calculate it:

IRR = I1 + NPV(+)NPV(+)–NPV(-) (I2– I1)

If the IRR is higher than the  discount rate,  the investment project can be continued. However, if the IRR is lower than the  discount rate,  then the investment project is not feasible.

5. Accounting Rate of Return (ARR)

The purpose of calculating the investment criteria on this one is to determine the ratio of the company’s average net profit when faced with the average investment. Here is the formula used to calculate it:

Accounting Rate of Return  = average net profit / average investment x 100%

Based on this formula, you can find out if the ARR is more than 0%, then the investment project is feasible to choose. However, if the ARR value is less than 0%, then the investment project is considered unfit for selection.

Investing Success Tips for Beginners 

Initially, novice investors may still be confused about starting to invest. If you are an investor who is also confused, take these steps to be successful in investing.

1. Determine your investment goals

Before starting, find out clearly what your goals are in investing. For example, you want to prepare an emergency fund, pension fund, education fund, and other needs. By determining your investment goals, you can build a strong commitment to achieving them. 

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2. Estimate investment funds 

After determining your investment goals, it’s time to calculate how much funds will be invested and how long it will take to achieve these goals. For example, you want to pay a down payment on a house of IDR 50 million and plan to buy it next year. For that, you need to calculate how much money you have to invest in a year.

3. Adjust to the risk profile

When investing, avoid investing if you are only tempted by the profits it generates. You also need to take into account the risks you may take. That is why, you need to study and calculate the investment criteria before starting.

4. Choose a product with good performance

In addition to looking at the risk profile, make sure you also choose a product that has performed well in the past 5 years.

5. Regularly invest

One of the keys to successful investing is to regularly distribute investment funds. Try to allocate some of the income you have consistently, either per week or per month.

That’s the information you can learn about what investment criteria are and how to calculate them, as well as what steps you can take to be successful in investing. 

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